By Ole Hansen, Head of Commodity Strategy at Saxo
 Ole Hansen |
Weakness was led by the energy sector, which suffered a near 9% decline – a decline that was made worse by a 26% slump in US natural gas futures. At the other end of the spectrum, we find gold and silver both benefiting from a big drop in US government bond yields, a weaker dollar and a sharp downward adjustment in future rate expectations from the US Federal Reserve. Despite seeing the banking sector turmoil ease towards the end of the month, precious metal prices held steady near a cycle high as investor demand continued to recover amid expectations supporting tailwinds can be maintained in the coming months.
The grains sector was heading for its first monthly gain this year, supported by renewed strength in corn prices as export demand picked up and after funds following a four-week period of record selling activity were forced to cover short positions as the technical and fundamental outlook showed sign of improving. Cocoa prices reached their highest level in three years on tight supply amid fears of a slowdown in shipments from West Africa, partly triggered by diseases and unfavourable weather conditions. Meanwhile, sugar prices hit their highest level in six years amid a disappointing sugar-cane output in places like Thailand and India and after a change in state fuel taxes in Brazil raised concerns more sugarcane will go towards production of ethanol instead of the sweetener.
Crude oil down but not out
Brent and WTI, the world’s two leading crude oil futures contracts, managed to recoup around half of the early March losses which accelerated mid-month as the banking crisis gathered strength. However, the strength of the selloff was driven mostly by the need from speculators and hedgers to reduce their net long positions more than the market pricing in a deteriorating demand outlook, and it explains why the price – following the initial selling phase – has managed to recover back to around $80 in Brent and $75 in WTI.
Ahead of the sudden selloff, crude oil had seen months of sideways trading and thus reducing volatility, thereby forcing speculators – who target a certain level of volatility in their portfolio – to increase their positions. And with Brent trading in a supportive backwardation structure, the focus had primarily been on building long positions ahead of an expected price rally as demand improved. As the crisis emerged, crude oil broke support and that opened the floodgates to selling, not only from the long liquidation but also from fresh short selling attempts.
During a two-week period to March 21, hedge funds sold WTI and Brent at the fastest pace in more than ten years with the combined net long slumping by 233k lots or 233 million barrels of crude oil to a three-year low at 241k lots. Selling hit WTI particularly hard with the net long slumping to 71k lots and lowest since 2016. As prices began to recover with the improved risk sentiment recently established, short positions were forced to take cover.
Crude oil traded firm ahead of month-end with the recent recovery being driven by continued supply disruptions from Northern Iraq amid a dispute between Baghdad and the Kurdistan region, a weaker dollar, the biggest drop in US crude stocks since November, China’s recovery showing continued strength and an improve risk sentiment forcing short covering. In a monthly survey published by the Dallas Fed, shale oil basin executives said the “uncertainty of the depth and duration of bank crisis is causing us to be nervous about capital spending plans in 2023”. In addition to access to credit, record costs from a shortage of labour and supply chain issues have led to a slowdown in production growth.
We maintain a moderate bullish outlook for crude oil as we are concerned that most of the still expected +2 million barrel a day increase in global demand this year is forecast to occur during the second half. With that in mind, a deeper than expected slowdown, as signalled by current U.S. rate cut expectations may reduce the eventual growth, thereby reducing the upside for crude oil later this year. However, in the short term, a break above $80.40 in Brent is likely to signal a return to the range that prevailed prior to the mid-March correction.
Gold’s short-term upside potential is being challenged by the gap
Following a month of turmoil across the banking industry, gold and silver is heading for monthly gains of around 8% and 14% respectively. Despite easing tensions this past week, both metals have managed to hold onto most of their gains in anticipation of a near-term peak in US rates being followed by a succession of rate cuts. However, this outlook could be challenged by the fact that the current 60% probability of a recession is most likely to high, certainly if we hold it up against an economic reading which still sees high inflation, full employment, and resilient consumers.
Having seen the Silicon Valley Bank collapse drive a U-turn in future rate expectations from additional hikes to expectations of +100 basis point cuts in the coming months, the market seems to want to force a recession. However, in our view, the path is one of a “slow recession” rather than a collapse. At Saxo, we see no cuts between now and September, and that could leave the precious metal market exposed should economic data, especially those covering inflation, continue to show strength.
Overall, it does not change the fact that the timing of peak rates has moved a lot closer and the combination of fresh demand for gold from ETF investors, momentum buying from hedge funds and continued physical demand from central banks will likely see gold and silver mover higher once the wide gap between current and future (lower) Fed funds rates begins to narrow.
On the upside, $2000 remains the key level to watch, while support is seen at $1933, the 38.2% retracement of the recent runup to $2010. In silver, watch a weekly close above $23.90 as it may signal a breakout of a two-year downtrend.
